Valuation of Technology Companies for IFRS Accounting Purposes
J.P. Morgan and McKinsey Technology M&A Workshop
February 7, 2018
ValueTrust Financial Advisors SE www.value-trust.com Agenda
Agenda Contact information
1. Start-up vs high growth companies: Still the dark side of valuation? 3 Prof. Dr. Christian Aders Chairman of the Executive Board 2. The Drillisch and 1&1 merger as case study 5 P: +49 (0)89 388 790 100 M: +49 (0)172 850 4839 3. Convergence period and consistent terminal value calculation 10 [email protected] 4. Valuation for IFRS impairment testing 16 i. Value in use 19 ii. Fair value less costs of disposal 24 5. Empirical analysis of tech and high growth companies 28 6. Practical implications and conclusion 34
Appendix 36 ValueTrust Financial Advisors SE Office Munich Theresienstrasse 1 80333 Munich Germany Office Frankfurt Bockenheimer Landstrasse 2-4 60306 Frankfurt am Main Germany www.value-trust.com
February 7, 2018 2 1. Start-up versus high growth companies Start-up versus high growth companies Still the dark side of valuation?
Start-up High growth
Characteristics Characteristics
§ Innovative business model § Technology, IP and brand mostly key value drivers & § High uncertainty differentiators § High growth rates and negative cash flows § Often in the group of market leaders § Tax losses § High investments in intangible assets § Equity financed and liquidation preferences § Partial debt financed (but often still liquidation § Often no benchmarks preferences before IPO or sale) § In some cases a real option exists § Decreasing insolvency risk and changing capital structure over time § Declining growth rates and ROIC excess returns mid and long term
Valuation issues Valuation issues
§ Discount rate for negative cash flows § Adjustment of cost of equity to decreasing § Scenario analysis operational risk profile § Changing risk profile over time § Cost of debt and tax shields are unsecure § Incorporation of insolvency risk in cost of equity or § Convergence rate for revenue growth and ROIC decision tree valuation approach § Appropriate planning horizon § Modeling of convergence from start up to high § Determination of long term growth rate and cost of growth company equity
February 7, 2018 4 2. The Drillisch and 1&1 merger as case study Drillisch and 1&1 Telecommunication merger
Background Valuation Opinion § In May 2017, Drillisch and United Internet entered into a Business Combination Agreement
Valuation expert to the governing the acquisition of 1&1 Telecommunication by Drillisch under United Internet. management board of § With the acquisition, the two companies merge Drillisch's and United Internet's business to create a strong fourth player in the German mobile market. on the acquisition of § United Internet transferred 1&1 Telecommunication shares to Drillisch in a capital increase by way of contribution-in-kind under the exclusion of subscription rights. In return, United Internet received new Drillisch shares. Provided a valuation opinion in connection with the contribution in kind and assessed the appropriateness of the proposed exchange ratio § The valuation of 1&1 Telecommunication is agreed at EUR 5.85 billion, while Drillisch is valued at EUR 2.99 billion.
Assignment ValueTrust has been retained to perform the following tasks to support the management: § Assess the appropriateness of the proposed exchange ratio for shares in Drillisch and 1&1 Telecommunication in the context of the contribution in kind § Analysis of the business plans including benchmarking and KPI analyses for both companies § Value Drillisch and 1&1 Telecommunication in accordance with the valuation standard of the Institute of Public Auditors in Germany (IDW S 1) as well as DVFA § Thereby using different valuation methods especially Discounted Cash Flow (DCF) after personal taxes according to IDW S 1, DCF before personal taxes according to DVFA and different industry multiples in the market multiple approach February 7, 2018 6 Transaction structure
Corporate structure prior to transaction: 100% United Internet United Internet AG Investments Holding GmbH 100% 20,08% 1&1 Telecommunication SE Drillisch AG
100% 85% 1&1 Telecom Other companies GmbH
Corporate structure after successful transaction: 100% United Internet United Internet AG Investments Holding GmbH >731) 1&1 100% Telecommunication SE Drillisch AG
100% 100% 1&1 Telecom Other companies GmbH
1) Status as of Q3 2017. February 7, 2018 7 Drillisch valuation is based on a two-phase model for reporting purposes
Planning period TV External view in EUR m 2017 2018 2019 2020 2021 § Five years planning period + Terminal Value Gross Performance 699 823 953 1,045 1,125 1,286 Growth (in %) 23.4% 17.7% 15.7% 9.7% 7.6% n.a. (TV) § Traditional auditors approach Gross Profit 326 391 436 477 516 522 Margin (in %) 46.6% 47.5% 45.7% 45.6% 45.9% 40.6%
EBITDA 174 235 278 313 348 300 Margin (in %) 24.8% 28.5% 29.2% 29.9% 31.0% 23.4% Internal view
EBIT 125 201 247 286 325 243 § 14 years convergence + TV Margin (in %) 17.9% 24.4% 25.9% 27.3% 28.9% 18.9% § Convergence required to model beneficial Net Income 89 139 173 198 224 168 contract expiring in 2030 Margin (in %) 12.7% 16.8% 18.1% 18.9% 19.9% 13.1% § No disclosure of confidential company g = 0.5% information beyond planning period
Timing of terminal value application should not affect equity value.
Source: ValueTrust report. February 7, 2018 8 Implementation of a convergence phase (three-phase-model) and estimation of the appropriate Terminal Value growth rate
Detailed Business Plan Convergence period Terminal Value
Nominal growth rate in %
g = 0.5% t 2017 - 2021 2022 - 2035
§ Expected market decline of approx. § Revenue growth above market § Stagnating revenues as well as high 2% p.a. projections competitive pressure in the telecommunications market § Revenue growth due to price § Continuation of EBIT margin due to advantage from purchase agreement contractually guaranteed purchasing § Strong focus on price-sensitive with Telefónica conditions until 2030 customers § The purchase agreement with Telefónica § After expiration of purchase agreement § Increasing EBIT margin through is about to expire in 2030 with Telefónica probably partial loss of economies of scale in procurement price-sensitive customers
Convergence period is required in order to model long-term strategy.
February 7, 2018 9 3. Convergence period and consistent terminal value calculation Traditional two-phase DCF-model uses Gordon-Growth-Model for TV calculation
Gordon- Business Plan Growth-Model
FCF t 1 t 2 t 3 t 4 t 5 Terminal T+1 + + + + + Value = 110 100 130 200 100 WACC – g
Enterprise = Value Present value of free cash flows (FCF)
The future cash flows are discounted with the „cost of capital (WACC)“; discounting converts the value of future cash flows into the value of the cash flows at the valuation date.
The enterprise value corresponds to the total amount of all discounted cash flows.
February 7, 2018 11 Calculation of terminal value within the WACC approach (Gordon Growth Model)
FCF: Free Cash Flow NOPLAT: Net Operating Profit IC × (ROIC - g) Less Adjusted Taxes TV = IC: Invested Capital WACC g - ∆IC: Change of Invested Capital mit: FCF = IC · (ROIC – g) ROIC: Return on Invested Capital (NOPLAT / IC) g: Growth rate of IC / FCF
Implicit assumptions in the Gordon-Growth-Model for the WACC approach:
- Constant leverage ! ³ - ROIC WACC Key: When are all variables constant? -gWACC = ROIC x Ie ΔIC - (Expansion-) Investment ratio: I = > 0 e NOPLAT
February 7, 2018 12 Competitive advantage period determines the planning horizon
The competitive advantage period (CAP) is the period during which the company achieves a return above the cost of capital. It can be seen separately from the length of the detailed planning horizon.
? ROIC > Economic reality: ROIC = WACC Competitive pressure reduces WACC profitability over time t Competitive Advantage Period
Implementation of a convergence period for modelling purposes using the DCF method: Detailed planning phase Terminal Value
ü Detailed planning phase Convergence phase Terminal Value
February 7, 2018 13 Implementation of convergence phase and estimation of the TV growth rate
Detailed Business Plan Convergence Phase Terminal Value Consistency of Assumptions
30% § The growth rate is usually determi- 25% ned exogenously based on market 19% analyses 20% 17% 14% • It has to be checked if the 10% NominalWachstum growth in % rate in % implicit ROIC resulting from this 10% 6% determination is higher than 2% 1% 1% the cost of capital (WACC):
0% 1 2 3 4 5 6 7 8 9 ROIC ³ WACC
§ § In the Detailed Planning Phase the § The Convergence Phase is mainly § The Terminal Value constitutes The growth rate can be determined business plan usually contains determined by the assumption of the the explicit valuation directly as a product of the sustain- able ROIC and reinvestment rate: • detailed assumptions speed of convergence (in other words assumption regarding the regarding growth and the number of years for convergence) sustainable growth level of the profitability, and to a “steady state” cash flows g = ROIC x I • detailed planning of income • Transition to Terminal Value § Precondition for the formula of statement, balance sheet • Derivation of long term growth the Terminal Value: State of and cashflow statement rate and transition to Terminal equilibrium and steadiness (so- The ROIC of the Terminal Value should be higher than the WACC § Typically, business plans show Value growth rate called “steady state”) still a very high growth rate and • Derivation of long term § Definition of the “steady state” margins above “market” level at profitability level and transition to requires Only when ROIC ³ WACC, a going the end of the detailed planning “market” margin • Constant growth/ profita- concern with retention makes phase • Derivation of dilution factor based bility/rentability sense on strategic analysis • Constant competition ratio/market share ratio The Convergence Phase has to be Immediate transition into etc. Otherwise the liquidation should Terminal Value inappropriate! long enough to reach the “steady be the alternative state”!
February 7, 2018 14 Nominal growth rate in Terminal Value is driven by multiple value drivers
g = ROIC x reinvestment rate (I)
§ Expected inflation
§ Expected real growth
§ Nominal industry growth
§ Position in competition
§ Sustainable ROIC level
§ Length of convergence period and planning horizon
February 7, 2018 15 4. Valuation for Impairment testing IAS 36: Impairment of assets
§ IAS 36 Impairment of Assets seeks to ensure that an entity's assets are not carried at more than their recoverable amount.
§ The impairment test may be conducted for an individual asset or a 'cash-generating unit‘ (CGU) where an asset does not generate cash inflows that are largely independent of those from other assets. Impairment Test § Entities are required to conduct tests for specific assets, in case there are any indications of impairments (triggering events).
Ø For goodwill and intangible assets with an indefinite useful life or intangible assets not yet available for use, an annual impairment test on CGU level is required.
February 7, 2018 17 Comparison of recoverable amount vs. carrying amount
§ An impairment exists, if the carrying amount of an asset or CGU exceeds the recoverable amount. Impairment § Consequently, the carrying amount of an impaired asset or CGU is written down to the recoverable amount.
Book values have to comply with the lower of
Recoverable Amount Carrying Amount of Asset / CGU of Asset / CGU
Corresponds to the higher of
Fair Value less Value in Use Costs of Disposal1)
An impairment loss is the amount by which the carrying amount of an asset/CGU exceeds its recoverable amount. The impairment loss is recognized as an expense.
1) Prior to consequential amendments made by IFRS 13 Fair Value Measurement, this was referred to as 'fair value less costs to sell'. February 7, 2018 18 4. i. Value in use Determination of value in use
“…the present value of future cash flows expected to be derived from an asset or cash-generating Value in Use unit.” [IAS 36.6]
§ The calculation of value in use should reflect the following elements [IAS 36.30]:
• an estimate of the future cash flows the entity expects to derive from the asset • expectations about possible variations in the amount or timing of those future cash flows • the time value of money, represented by the current market risk-free rate of interest • the price for bearing the uncertainty inherent in the asset • other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset
§ Cash flow projections should be based on reasonable and supportable assumptions, the most recent budgets and forecasts, and extrapolation for periods beyond budgeted projections. [IAS 36.33]
February 7, 2018 20 IAS 36.33 requirements and implication for planning horizon
§ IAS 36.33 states that:
§ IAS 36.33 (b) presumes that budgets and forecasts for the planning period of a company should not go beyond five years.
§ Due to IAS 36.33 (c) an extrapolation of cash flows of the last planned year with a stable or decreasing growth rate for the following years is required by IFRS after the detailed planning period.
The requirement of sustainable parameters for a terminal value after only 5 years is normally a contra- diction in terms due to a lack of immediate steady state after the detailed planning period.
February 7, 2018 21 IAS 36.33 requirements and implication for planning horizon
§ IAS 36.33 states that:
§ Precondition for terminal value from valuation perspective: a steady state has been reached, where cash flows only fluctuate marginally and a clear trend is observable.
§ Since the steady state is seldom accomplished after the detailed planning phase, an extrapolation of cash flows through a convergence phase is used for modeling purposes to smooth future cash flows towards the long term steady state (i.e. terminal value).
In order to meet the IFRS requirements and resolve the contradiction of sustainable parameters, it can be appropriate to use a convergence phase exceeding 5 periods and discount the present value equivalent with an annuity conversion factor of all future cash flows after a planning period of five years.
February 7, 2018 22 Value in use: Practical example of present value conversion
Impairment Test - Valuation CGU Example, Inc. PLAN PLAN PLAN PLAN CONVPLAN CONV CONV CONV CONV STEADY STATE TV YTG 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2026 Financials in EUR m (unless otherwise stated) 31.12.2017 31.12.2018 31.12.2019 31.12.2020 31.12.2021 31.12.2022 31.12.2023 31.12.2024 31.12.2025 31.12.2026 31.12.2026 Value in use calculation and impairment test
Revenues 49.6 710.2 749.0 824.8 893.2 951.0 995.2 1,023.3 1,033.5 1,043.8 Growth (yoy) n/a 5.5% 10.1% 8.3% 6.5% 4.6% 2.8% 1.0% 1.0% Gross profit 12.3 200.8 225.0 250.9 267.0 279.3 287.0 289.7 287.2 290.0 Gross margin (%) 28.3% 30.0% 30.4% 29.9% 29.4% 28.8% 28.3% 27.8% EBIT 4.0 90.7 103.0 116.6 121.6 124.4 124.9 123.1 118.9 120.0 EBIT margin (%) 12.8% 13.8% 14.1% 13.6% 13.1% 12.6% 12.0% 11.5% 11.5% - income taxes -1.1 -25.4 -28.8 -32.6 -34.0 -34.8 -35.0 -34.5 -33.3 -33.6 NOPLAT 2.9 65.3 74.2 83.9 87.5 89.6 90.0 88.6 85.6 86.4 + D&A 1.4 19.6 24.0 28.5 30.1 31.1 31.7 31.6 31.0 31.3 - Capex -4.9 -57.8 -53.5 -46.1 -46.1 -44.9 -42.7 -39.5 -35.4 -35.8 - Change in NWC 3.5 -1.7 -8.8 -10.4 -19.0 -16.0 -12.2 -7.6 -2.6 -2.9 - Others (incl. change in provisions) -1.7 7.8 2.8 3.5 2.8 2.1 1.4 0.7 0.0 0.0 Cash flow 1.2 33.2 38.6 59.5 55.3 61.8 68.1 73.8 78.5 79.0 1631.1 discount factor 1.00 0.94 0.89 0.84 0.79 0.75 0.71 0.67 0.63 0.59 0.59 Present value of cash flow 1.2 31.2 34.3 49.8 43.7 46.2 48.1 49.2 49.4 47.0 969.5 Present value CF plan & conv 400.1 Present value CF terminal value 969.5 Value in use of CGU Example 1,369.6
Impairment Test - Valuation CGU Example, Inc. PLAN PLAN PLAN PLAN CONVPLAN CONVTV YTG 2017 2018 2019 2020 2021 2022 Financials in EUR m (unless otherwise stated) 31.12.2017 31.12.2018 31.12.2019 31.12.2020 31.12.2021 31.12.2022 Present value of all Additional calculation: Conversion to 5 year planning period Revenues 49.6 710.2 749.0 824.8 893.2 1,048.4 discounted future cash Growth (yoy) 5.5% 10.1% 8.3% 17.4% Gross profit 12.3 200.8 225.0 250.9 267.0 292.7 flows (convergence period Gross margin (%) 28.3% 30.0% 30.4% 29.9% 27.9% EBIT 4.0 90.7 103.0 116.6 121.6 122.0 and terminal value) leads EBIT margin (%) 12.8% 13.8% 14.1% 13.6% 11.6% - income taxes -1.1 -25.4 -28.8 -32.6 -34.0 -34.2 to same value in use NOPLAT 2.9 65.3 74.2 83.9 87.5 87.8 + D&A 1.4 19.6 24.0 28.5 30.1 31.7 - Capex -4.9 -57.8 -53.5 -46.1 -46.1 -37.1 - Change in NWC 3.5 -1.7 -8.8 -10.4 -19.0 -4.2 - Others (incl. change in provisions) -1.7 7.8 2.8 3.5 2.8 0.2 Cash flow 1.2 33.2 38.6 59.5 55.3 78.4 discount factor 1.00 0.94 0.89 0.84 0.79 15.42 Present value of cash flow 1.2 31.2 34.3 49.8 43.7 1209.4
Value in use of CGU Example 1,369.6
February 7, 2018 23 4. ii. Fair value less costs of disposal Determination of fair value less costs of disposal
“Fair value is the price that would be received to sell an asset or paid to a liability in an orderly Fair value transaction between market participants at the measurement date.” [IFRS 13]
Fair value hierarchy
Level 1 Quoted prices for identical instruments
Level 2 Directly or indirectly observable parameters: § Quoted prices for similar products on active markets § Quoted prices on inactive markets § Observable interest rates, implicit volatilities & credit spreads § Market-supported inputs (extrapolation, correlation of indices)
Level 3 Not observable parameters: § Estimation based on past data § Discounted cash flow methods
February 7, 2018 25 Examples for fair value hierarchy
“Fair value is the price that would be received to sell an asset or paid to a liability in an orderly Fair value transaction between market participants at the measurement date.” [IFRS 13]
“The recoverable amount of the CGU is determined through a fair value less cost to sell calculation. […] As AIXTRON has only one CGU, market capitalization of AIXTRON, adjusted for a control premium, has been used to determine the fair value less cost to sell of the CGU. This is level 2 in the hierarchy of fair value measures set out in IFRS 13.” (AIXTRON SE, Annual Report 2016)
Level 1
Level 2
Level 3
“The recoverable amount or the fair value less cost of sale […] is calculated based on the budget for 2017 as well as four subsequent budget years derived from company`s medium-term forecasts. Income beyond the five-year period has been extrapolated based on a steady growth rate of 1.00%. The fair value determined for both segments is assigned to Level 3 in the fair value hierarchy.” (Nordex SE, Annual Report 2016)
February 7, 2018 26 Fair value less costs of disposal vs value in use
IAS 36: Fair value less costs of disposal IAS 36: Value in use
Valuation object CGU/asset
Perspective of valuation Typified market participant’s view Reporting company’s view
IFRS 13: Market approach, Valuation method Income approach (DCF) Income approach (DCF)
Planning period Market participant’s view In general 5 years
Synergies Synergies of market participant All synergies
Cash flow: Consideration of Measures which would be undertaken by expansion investment and Not to be considered market participant restructuring measures
WACC-Approach: Capital structure of peer group, cost of debt and beta; In practice: Consideration of taxes (WACC after taxes)
Cost of capital n/a Recursive determination of pre-tax WACC
Limited long-term growth due to non- Long-term market growth rate consideration of expansion capex
February 7, 2018 27 5. Empirical analysis of tech and high growth companies Key observations: TecDAX companies
Analysis of impairment testing among TecDAX companies Recoverable amount calculated as: 3.3%
§ The analysis is based on the 30 companies from the TecDAX Index. 6.7%
§ The value in use concept was mainly used as recoverable amount 13.3% Value in use in order to conduct a goodwill impairment test of CGUs. Fair Value (level 3) n = 30 Consequently, the fair value less costs of disposal was rarely Fair Value (level 2) observed and often stated to be lower than the value in use. 76.7% No goodwill § The vast majority of the analyzed TecDAX companies (23 of 30) used the value in use as recoverable amount, while six entities applied the fair value less costs of disposal. According to the fair value hierarchy of IFRS 13, four fair values were derived using DCF-model parameters: level 3 and two using level 2. n=17 n=23
§ The WACC (before taxes) for the analyzed TecDAX companies 17% 2.0% - 3.0% amounted on average to 9.7%, while the observed terminal value >11.0% 35% 17% 1.5% - 2.0% growth rates were on average 1.2%. § Planning periods are usually 5 years or shorter, as generally 8.0% - 10.5% 24% 43% 1.0% required by IAS 36. However, especially for project-related CGUs there is a tendency towards longer planning periods (e.g. 22 years 6.5% - 8.0% 35% for EVOTEC). 22% <0.5% < 5.0% 6% WACC TV Growth Rate (before taxes)
Procedure for goodwill impairment testing in TecDAX companies is diversified, with a majority of companies applying the value in use concept (77%). Discount rates (average of 9.7% before taxes for value in use) and terminal value growth rates (average of 1.2%) are on moderate levels.
February 7, 2018 29 Key observations: MSCI Europe Small Cap Index
Analysis of impairment testing among MSCI Europe Small Cap Recoverable amount calculated as: companies
12.0%
§ The following analysis of high growth companies examines Value in use 25 companies from the MSCI Europe Small Cap Index. Fair Value (level 3) § Selection criteria: Above average with regard to market n = 25 capitalization and 3-year revenue-CAGR compared to the other index companies. 88.0% § The value in use concept was mainly used as recoverable amount in order to conduct a goodwill impairment test of CGUs. DCF-model parameters: § Three entities of the analyzed MSCI Europe Small Cap companies n=19n=9 n=22 applied the fair value less costs of disposal (level 3). § The WACC (before taxes) for the analyzed companies amounted 11.0% - 13.0% 26% 27% 2.0% - 3.0% on average to 9.5%, while the observed terminal value growth 10.0% - 11.0% 21% rates were on average 1.8%, fluctuating around target inflation 32% 2.0% rate of 2%;. 8.5% - 10.0% 21% § Planning periods are on average 4.4 years, as generally required 14% 1.5% by IAS 36. <8.5% 32% 27% 0.5 - 1.0%
WACC TV Growth Rate (before taxes)
The terminal value growth rates of selected companies included in the MSCI Europe Small Cap Index are on average 1.8% and, therefore, higher than the observed growth rates of TecDAX companies.
February 7, 2018 30 Key observations: Additionally selected growth companies
Analysis of impairment testing among high growth companies Recoverable amount calculated as:
§ The following analysis examines 10 additionally selected 1) European growth companies. Value in use § Only the value in use concept was used as recoverable amount in order to conduct a goodwill impairment test of CGUs. n = 10 § The WACC (before taxes) for the analyzed companies amounted on average to 11.9%, while the observed terminal value growth 100.0% rates were on average 2.4%.
§ Planning periods are on average 4.6 years, as generally required DCF-model parameters: by IAS 36. n=10 n=10
20% 3.5% - 4.5% 12.5% - 16.0% 40%
60% 2.0 - 3.0% 11.0% - 12.0% 30%
10.0% - 11.0% 20% 20% 0.5% 8.5% 10% WACC TV Growth Rate (before taxes)
The terminal value growth rates of additionally selected European growth companies are on average 2.4% and, therefore, higher than the observed growth rates of selected MSCI Europe Small Cap Index companies.
1) Criteria: Market capitalization > EUR 1bn; 3-year-revenue-CAGR > 20%. February 7, 2018 31 Analysis of goodwill impairment and corresponding transaction
Purpose: Examining the relationship between goodwill impairment and the corresponding transaction
1. Selection of the company base to be analyzed: § 30 companies based on the S&P Capital IQ database mainly with following criteria: latest market capitalization > EUR 500m, geographical location Europe, goodwill impairment > EUR 50m, all industries except Financials
§ 15 companies based on findings of diverse impairment and cost of capital studies (Duff & Phelps, KPMG, etc.)
§ Over 20 companies based on further information sources (company reports, google search, press releases, newsletters, etc.)
§ The companies selected are located in Europe and are reporting under IFRS. In addition to these, we analyzed 6 acquisitions of famous big-cap companies from the USA and Japan that led to significant goodwill impairment
§ The analysis comprises financial reports of the observation period 2005-2016
2. Analyzing the company database: § The annual and interim financial reports of the selected companies were examined with regard to goodwill impairment date and volume, the related transaction date and volume and the initial goodwill recognition as well as the reasons for the goodwill impairment
Overall more than 70 companies were selected for the analysis purposes. The annual and interim financial reports of the companies were examined with regard to goodwill impairment, the related transaction and the time period between the transaction and the impairment.
February 7, 2018 32 Analysis of goodwill impairment and corresponding transaction
Main findings: § The number of financial reports with sufficient disclosures for analysis purposes is strongly limited § In most cases the companies refer to cash generating units and do not specify the transaction the goodwill impairment relates to
Initial goodwill Transaction Amount of goodwill Geographical Transaction amount of Goodwill Buyer Target volume impairment Reasons for impairment location date transaction impairmentdate in m EUR in m EUR in m EUR ACEA S.p.A. Europe Crea Group n.a. n.a. n.a. FY 2010 3.4 n.a. Adidas AG Europe Reebok Int. Ltd. 03.08.2005 3,800 1,165 FY 2012 265 Adjusted growth assumptions Economic slowdown, tough competition, Deutsche Telekom AG Europe T-Mobile UK n.a. n.a. n.a. FY 2009 1,800 regulatory decisions in the UK
§ In some cases the goodwill was written off even within one year after the transaction was closed
Initial goodwill Transaction Amount of goodwill Geographical Transaction amount of Goodwill Buyer Target volume impairment Reasons for impairment location date transaction impairmentdate in m EUR in m EUR in m EUR Grupo Yamm Comida Rocket Internet SE Europe 26.01.2015 80.4 70.1 FY 2015 3.7 n.a. a Diomicilio S.l. Rocket Internet SE Europe WEBs S.r.l. 30.01.2015 51.3 45.2 FY 2015 14.4 n.a. Jiangsu Zeversolar Change in the sales estimate incorporated SMA Solar Technology AG Europe 12.03.2013 22.1 12.9 FY 2013 12.9 New Energy Co. Ltd. into the company’s planning § Famous multinational companies recorded significant goodwill charges due to unsuccessful acquisitions
Initial goodwill Transaction Amount of goodwill Geographical Transaction amount of Goodwill Buyer Target volume impairment Reasons for impairment location date transaction impairmentdate in m USD in m USD In m USD Accounting improprieties, HP Inc. USA Autonomy 13.10.2011 10,395 6,600 FY 2012 5,700 misrepresentations and disclosure failures by the previous management Decline in demand resulting from drop in Sumitomo Corporation Japan Edgen Group 20.11.2013 820.2 323 FY 2016 178 oil prices
Only few companies disclose detailed information concerning the goodwill impairment and the related transaction in their financial reports. Goodwill impairment shortly after acquisition is observable, but seldom.
February 7, 2018 33 6. Practical implications and conclusion Practical implications and conclusion
§ In practice, auditors and regulators interpret IFRS rules more flexible and focus on underlying value and growth drivers
§ Companies should not limit flexibility by focusing on only one valuation concept (e.g. Value in use)
§ Three-phase-models are frequently used to derive sustainable free cash flows and accurate DCF values and do not contradict IFRS principles
Conclusion § Documentation is key! - Underlying technology cycles and growth assumptions should be properly documented and linked to cash flow planning - Benchmarking with market data adds reliability to chosen valuation concept and establishes value ranges
§ German auditors have a specific standard (and methodology) to check plausibility of business plans (IDW Praxishinweis 2/2017)
§ Documentation of planning accuracy helps to build trust with auditors
February 7, 2018 35 Appendix Empirical analysis of high growth companies Detailed analysis of companies from the TecDAX Index (1)
Overview of key inputs for goodwill impairment testing of CGUs located in developed markets (2016)
Discount rate Terminal value growth TecDAX companies (1) Recoverable amount derivation Planning period Auditor (WACC before taxes) rate
Bechtle Value in use 4.5% 1.9% 2 years Ernst & Young
Carl Zeiss Meditec Value in use - 1.0% 5 years Ernst & Young
CompuGroup Medical Value in use 7.5 – 10.2% (after taxes) 1.0% 5 years PWC
Dialog Semiconductor Value in use 11.2 – 14.3% 2.0% 3 years Deloitte
Drägerwerk Value in use 7.3% (after taxes) 1.0% 5 years Deloitte
Evotec Value in use 6.6 – 10.8% (after taxes) 0.0% 5 – 22 years Ernst & Young
Jenoptik Value in use 5.8 – 8.3% (after taxes) 0.9 – 1.1% 5 years Ernst & Young
Nordex Fair value less costs of disposal (IFRS 13 level 3) 8.9 – 9.6% 1.0% 5 years PWC
Siltronic Value in use 10.4% 0.0% - KPMG
United Internet Fair value less costs of disposal (IFRS 13 level 3) 5.0 – 8.0% (after taxes) 0.5% 12 years BDO
Wirecard Value in use 7.5 – 9.9% (after taxes) 1.0 – 2.0% 5 years Ernst & Young
Cancom Value in use 7.0% 0.0% 5 years S&P
RIB Software Value in use 6.9 – 8.1% 1.0% 5 years BW Partner
Sartorius Value in use 7.9 – 8.8% 1.5 – 2.5% 4 years KPMG
Xing Value in use 7.9% 2.0% 3 - 5 years PWC
Telefónica Deutschland1) Fair value less costs of disposal (IFRS 13 level 2) - - - Ernst & Young
Drillisch Value in use 5.7 – 9.4% 0.5% 5 years BDO
freenet Fair value less costs of disposal (IFRS 13 level 3) 6.0 – 7.4% (after taxes) 0.0 – 1.0% 4 years PWC
Software Aktiengesellschaft Fair value less costs of disposal (IFRS 13 level 3) 6.4 – 7.6% (after taxes) 0.0 – 2.0% 3 years BDO
Pfeiffer Vacuum Technology Value in use 7.8 – 10.3% 1.5% 3 years Ernst & Young
1)Fair value derived from current market cap. February 7, 2018 37 Empirical analysis of high growth companies Detailed analysis of companies from the TecDAX Index (2)
Overview of key inputs for goodwill impairment testing of CGUs located in developed markets (2016)
Discount rate Terminal value growth TecDAX companies (2) Recoverable amount derivation Planning period Auditor (WACC before taxes) rate
S&T Value in use 8.4 – 22.3% 1.0% 4 years Ernst & Young
Aixtron1) Fair value less costs of disposal (IFRS 13 level 2) - - - Deloitte
SLM Solutions2) - - - - PWC
GFT Technologies Value in use 11.2 – 11.4% 1.0% 4 years KPMG Grant Thornton ADVA Optical Networking Value in use 6.8 – 8.3% 0.0% 3 years International Morphosys Value in use 11.9 – 12.2% 1.0% 10 - 30 years PWC
SMA Solar Technology Value in use 13.4 – 14.7% 1.0% 3 years Deloitte
Medigene Value in use 9.9% (after taxes) - 20 - 24 years Ernst & Young
Nemetschek Value in use 10.9 – 13.8% 1.9% 3 - 4 years Ernst & Young
QIAGEN Value in use 6.8% 3.0% 5 years KPMG
Average3) (value in use) n/a 9.7%4) 1.2%5) 4.1 years5) n/a
Average3) (fair value less cost of n/a 9.3%4) 0.8%5) 4.0 years5) n/a disposal)
1)Fair value derived from current market cap. 2)no goodwill in the balance sheet. 3) In order to estimate bandwidths, the average was chosen. 4) Average without considering after-tax values. 5) Average without Evotec, United Internet, Morphosys and Medigene (planning periods of > 5 years). February 7, 2018 38 Empirical analysis of high growth companies Detailed analysis of selected companies from MSCI Europe Small Cap Index (1)
Overview of key inputs for goodwill impairment testing of CGUs located in developed markets (2016)
Discount rate Terminal value growth Selection from Index1) (1) Recoverable amount derivation Planning period Auditor (WACC before taxes) rate
Rheinmetall Value in use 9.3 – 10.9% 1.0% 3 years PWC
Aalberts Industries Value in use 9.7 – 15.7% 1.0% 5 years Deloitte
Moncler Value in use 8.3% 2.0% 3 years KPMG
Informa Fair value less costs of disposal (IFRS 13 level 3) 8.9 – 14.9% 1.9 – 3.9% 5 years Deloitte
Hiscox Value in use 6.6% - 5 years PWC
Compagnie Plastic Omnium Value in use 7.5 – 9.0% (after taxes) 1.5% 4 years EY
Ald Value in use 5.0 – 12.4% 2.0% 5 years Deloitte
Rubis Value in use 4.8 – 11.5% 1.0% 3 years Mazars Group
SSAB Value in use 7.1 –10.3% 2.0% 5 years PWC
Hapag Lloyd Value in use 8.2% (after taxes) 1.0% 5 years KPMG
LEG Immobilien Fair value less costs of disposal (IFRS 13 level 3) 3.2% 0.8% 5 years PWC
OCI Value in use 10.5 – 13.6% 1.5% 7 years KPMG
DS Smith Value in use 9.5% 1.5% 2 years Deloitte
Orpea Value in use 6.5% 1.5% 5 years Deloitte
YOOX Net-A-Porter Group Value in use 8.3% (after taxes) 2.5% 4 years KPMG
1) Criteria: Top 25 Index companies by market capitalization and 3-year-revenue-CAGR. February 7, 2018 39 Empirical analysis of high growth companies Detailed analysis of selected companies from MSCI Europe Small Cap Index (2)
Overview of key inputs for goodwill impairment testing of CGUs located in developed markets (2016)
Discount rate Terminal value growth Selection from Index1) (2) Recoverable amount derivation Planning period Auditor (WACC before taxes) rate
NMC Health Value in use 8.5% 3.0% 5 years Delgawi
Rentokil Initial Value in use 8.0% –13.0% 0.9 – 5.0% 5 years KPMG
Temenos Group Value in use 10.8% 1.0% 4 years PWC
Kingspan Group Value in use 7.8% – 9,5% 2.0% 5 years KPMG
Halma Value in use 8.8% – 12.5% 1.9 – 2.6% 4 years Deloitte
Austriamicrosystems INH2 Fair value less costs of disposal (IFRS 13 level 3) - 2.0% 5 years KPMG
Melrose Industries Value in use 11.0% – 12.8% 2.2 – 3.0% 4 – 5 years Deloitte
Just Eat Value in use 9.3% – 16.1% 1.5 – 3.6% 5 – 8 years Deloitte
Trelleborg Group Value in use 7.2% (after taxes) 2.0% 5 years PWC
Gemalto Value in use 9.5% (after taxes) 2.0% 4 years KPMG
Average3) (value in use) n/a 9.7%4) 1.8% 4.3 years5) n/a
Average3) (fair value less cost of n/a 7.6%4) 1.9% 5.0 years n/a disposal)
1) Criteria: Top 25 Index companies by market capitalization and 3-year-revenue-CAGR. 2) fair value via multiples; DCF for plausibility. 3) In order to estimate bandwidths, the average was chosen. 4) Average without considering after-tax values. 5) Average without JUST EAT and OCI (planning periods of > 5 years). February 7, 2018 40 Empirical analysis of high growth companies Detailed analysis of additionally selected growth companies
Overview of key inputs for goodwill impairment testing of CGUs located in developed markets (2016)
Discount rate Terminal value growth Selected company1) Recoverable amount derivation Planning period Auditor (WACC before taxes) rate
Micro Focus Internat. 2) Value in use 11.4% 1 – 5% 5 years PWC
Paddy Power Betfair Value in use 9.0 – 13.5% 2 - 5% 3 – 10 years KPMG
YOOX Net-A-Porter Group Value in use 8.3 (after taxes) 2,5% 4 years KPMG
Basic-Fit Value in use 10.3 – 13% 0,5% 5 years Ernst & Young
Takeaway.com Value in use 10.1 – 10.2% 0,5% 5 – 10 years Deloitte
JUST EAT Value in use 9.3 – 16.1% 1.5 – 3.6% 5 – 8 years Deloitte
Keywords Studios Value in use 12.5% 2% 5 years BDO
NMC Health Value in use 8.5% 3% 5 years Delgawi
RPC Group Value in use 10 – 12% 0 – 4% 3 years Deloitte
Sanne Group Value in use 10.4 – 16.7% 4 - 5% 5 years Deloitte
X5 Retail Group Value in use 15.9% - 10 years Ernst & Young
Average3) n/a 11.9%4) 2.4% 4.6 years5) n/a
1) Criteria: Market capitalization > EUR 1bn; 3-year-revenue-CAGR > 20% 2) FY 2017 3) In order to estimate bandwidths, the average was chosen. 4) Average without considering after-tax values. 5) Average without Paddy Power Betfair, Takeaway.com, JUST EAT and X5 Retail Group (planning periods of > 5 years). February 7, 2018 41